When doing an analysis on a property, one of the things you should account for is a reserve fund. Our clients allow us to hold a reserve in their account for them. Actually we require it. It’s a relatively small amount but it’s enough to cover most any expense that comes up after we distribute their funds to them every month.
But that’s not the reserve that I’m talking about. Your reserve should be sufficient enough to cover one of two things. First, major expenses like a roof or air conditioner. Granted, you should have accounted for these things and adjusted the purchase price when you first bought your property. But knowing this expense will be coming up; you should have those funds set aside. The second reason for a reserve is something that you can count on happening. You’re going to have a vacant property. Make sure you have enough to cover the mortgage while your property is vacant. If you don’t, you’ll have a tendency to become emotional about finding a new tenant and will soon settle for a less than desirable tenant. Doing so will more than likely be more costly than allowing your property to go vacant for a longer period of time.
There are different trains of thought on reserve; some say you should have a separate reserve for each property and your analysis should include the reserve. In fact, your bank may require you to have a set reserve when considering approving your loan. I personally don’t think you need to. You know your properties and know the condition of things like the roof and air conditioner and the chances of having multiple vacancies at the same time are low. You also know your cash flow and can figure out how long it will take to replenish your reserve. With proper planning and a watchful eye you can free up some cash to put towards additional properties.
One last note. If you have plenty of equity in your portfolio, I don’t see a problem with having an equity line of credit to use towards your reserve.
We have seen owners who did not manage their reserves properly and the outcome has been very unfortunate.
Here’s to keeping cash flow positive,
Dave
